Energy demand is expected to pick up in the year ahead after faltering in 2017. EV sales will rise

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India's stellar oil-demand story stumbled in 2017. Following record-high demand growth in 2015 (303,000 barrels a day) and 2016 (380,000 b/d), 2017 was much more variable, falling by 88,000 b/d in the first quarter, recovering to 153,000 b/d in the second, and witnessing the largest year-on-year drop since 2006 in August, before recovering in September (numbers from Energy Aspects). Barring widespread flooding in August, these included policy-induced shocks: the demonetisation of 86% of currency in late 2016 and introduction of a new Goods and Services Tax (GST) in mid-2017 hit business activity and consumption.

Consequently, GDP-growth forecasts for 2017 and 2018 have been pared down by the IMF to 6.7% and 7.4%. While these are still among the fastest in emerging markets, uncertainty remains over how quickly structural reforms will be consolidated in 2018 and whether further measures will be implemented to support a recovery—the petroleum ministry, for instance, will be pushing to bring petroleum products under the GST, which could lower taxes and boost demand.

Recovery, nevertheless, seems imminent, given favourable demographics and rising per capita income, and will be supported by private consumption—rising vehicle ownership in particular. India's vehicle fleet doubled from 96m to just under 200m from 2007-14, constituting the fifth-largest car and largest two-wheeler market, with transportation accounting for 40% of oil demand. Private—and commercial—vehicle sales are likely to continue growing year-on-year at rates over 10%. Restrictions on 10-year-old diesel vehicles are likely to ramp up across metropolitan areas to combat air pollution; as the majority of new sales go towards fleet expansion rather than replacement, this is unlikely to significantly affect oil demand.

At the same time, India's push for electric vehicles (EVs) will gain momentum in 2018, given its 2030 target to leapfrog over hybrids to an all-EV fleet. The government estimates this could save $60bn in oil imports and reduce emissions by 37%. Pending a cohesive EV policy, which automakers will be seeking before they expand into India's EV market, efforts in 2018 may be limited to low-hanging fruit—public transportation and replacement of government-owned gasoline and diesel vehicles. Following the federal government's first tender for 10,000 EVs (won by Tata Motors), a second for 20,000 EVs is expected in 2018.

Federal funding may be extended to cities to encourage the adoption of multi-modal electric public transport—grants of around $18m are reportedly being considered for qualifying cities with populations exceeding 1m. EVs in India comprise under 1% of the vehicle fleet, and scaling them up among private and commercial users will require transformative investments, particularly in infrastructure—according to International Energy Agency estimates there are only 328 public charging stations across India.

The preference for local manufacturing under the "Make in India" scheme constitutes a potential hurdle, as supply chains are weak. Alongside government tenders, pockets of organic growth will continue emerging in 2018, such as the partnership between Indian ride-sharing company Ola and Indian EV-manufacturer Mahindra & Mahindra in a Tier-2 city in Maharashtra, which includes a $7.7m investment towards 200 EV taxis and charging infrastructure. In September 2017, Karnataka became the first Indian state to announce an EV and energy-storage policy; other states could follow suit in 2018.

In the short term, however, India's government envisages rising oil demand and imports. Its 2017 upstream reforms included the launch of an open acreage Hydrocarbon Exploration Licensing Policy (Help) and a round of marginal field auctions—both under revenue-sharing contracts. These were targeted towards reducing oil imports by 10% by 2022, which would require boosting production by around 400,000 b/d (50% higher than 2016 production of 0.856m b/d).

While a further round is likely in 2018, another important upstream reform could be the bidding out of undeveloped legacy assets of India's national oil companies, either through contracting technical expertise on production-enhancement contracts, or the farming out of a substantial percentage of interest. Legacy assets (also called nomination acreage) are perceived as containing some of India's most valuable hydrocarbon resources, and could yield production more quickly than Help acreage. As a result, they could attract more investor attention.

Natural gas has enjoyed a brief renaissance in India with imports rising from 14bn to 25bn cubic metres a year (reaching nearly 50% of gas consumption) over 2014-17, mainly due to low global prices. Despite its successful price renegotiation of two long-term liquefied natural gas contracts (with RasGas and ExxonMobil), India's preference for flexible, low-cost supplies is likely to continue. The percentages of spot/short-term versus long-term-contracted imports, which were 18% and 82% in 2010, had nearly equalised by 2015-16.

Two regasification terminals, Ennore and Mundra (each with 5m tonnes a year of capacity), are scheduled for completion in 2018, potentially adding to the existing 25m t/y; but given the history of delays in liquefied natural gas projects, it will be unsurprising if this deadline is missed. India's first floating storage regasification unit (FSRU), being built by Indian firm H-Energy, is expected to be operational by May 2018, and could prove whether or not FSRUs could be a way to overcome infrastructural constraints in reaching the Indian market.

The coming year is also likely to see the outcome of the petroleum ministry's efforts towards setting up a gas-trading exchange in order to commercialise the fuel more widely. In terms of demand growth, there's a limited but reliable base for gas comprising the fertiliser, city gas and industry (including manufacturing of petrochemicals, liquefied petroleum gas and refineries) sectors, all of which have underpinning targets to expand production/capacity over the next five years.

Gas consumption in these sectors should continue to grow comfortably, potentially increasing by around 30% over 2015 levels by 2020. The main risk to this outlook is a potential slowdown in manufacturing. Scaling up beyond this would require disincentives to competing fuels (such as coal), as well as reforms to encourage the construction and use of pipeline-distribution networks.

India's big success in recent years has undoubtedly been in solar energy—it reportedly had 12.29 gigawatts of solar capacity as of March 2017, and is chasing a 100GW goal by 2022. Solar auctions have, therefore, been conducted at a breath-taking pace, with the tariffs bid in 2017 being 50% lower than in 2015. It has been estimated that India will add 8.8GW of new solar capacity in 2017, 76% higher than 2016. But these tariffs—the lowest being $0.04/kilowatt-hour in May 2017—have raised concerns of a solar bubble developing. They are predicated on low-cost solar-equipment imports from China, and developers may not have adequately priced in risks of rising supply costs, or costs of integration as solar energy is scaled up in the system.

The steep fall in tariffs over a short period of time has also led some state utilities to delay signing power-purchase agreements that should have been concluded months ago with solar developers, to demand lower tariffs. A key risk to solar, as with all electricity generation in India, is whether utilities will eventually offtake (and pay for) solar power, as renewable purchase obligations frequently go unfulfilled. There are indications that the pace of solar additions will slow down in 2018, as the market consolidates and corrects for these risks.

While the past two years have been about initiating significant and sometimes controversial policy changes affecting almost every sphere of the energy sector, 2018 is likely to bring in a period of consolidation, as energy markets and the economy adapt to these changes. It's also likely to bring a final push to implement policy promises before India moves into the 2019 general election cycle, closer to which it will be harder to implement big reforms. So 2018 will be about maintaining momentum.

This article is part of Outlook 2018, our annual book looking at energy market trends for the year ahead. To purchase a copy,click here